The United States Internal Revenue Service (IRS) has issued a temporary reprieve for a rule that would have automatically defaulted cryptocurrency holders on centralized exchanges to the First-In, First-Out (FIFO) accounting method. This move comes as a relief to investors who were concerned about the potential impact of this ruling on their tax obligations.
Background on the IRS Ruling
Initially, the IRS stated that if crypto asset holders with a CeFi broker did not select their preferred accounting method, such as HIFO (Highest In, First Out) or Spec ID, the broker would default to reporting sales using the FIFO method. This ruling sparked concerns among investors and experts in the cryptocurrency space.
What is FIFO?
FIFO, also known as ‘First In, First Out,’ is the default method for calculating capital gains tax in the US. It is calculated by assuming that the oldest cryptocurrency bought is sold first, which can lead to higher capital gains for taxpayers.
Consequences of Imposing the Rule Immediately
Cointracker head of tax Shehan Chandrasekera warned that imposing this rule immediately could have been disastrous for many crypto taxpayers during a bull market. He explained that investors might unintentionally sell their earliest purchased assets – those with the lowest cost basis – first, thereby unknowingly maximizing their capital gains.
Temporary Relief
The temporary relief applies to sales on centralized crypto exchanges until Dec. 31, 2025. This gives brokers time to support all accounting methods, and crypto taxpayers will be able to maintain their own records until that date.
Blockchain Association Takes Legal Action Against IRS
This update comes just days after the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS on Dec. 28, arguing that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs) are unconstitutional.
Implications of the Ruling
Once the rules take effect in 2027, brokers must disclose information about taxpayers involved in digital asset transactions. The brokers must also report their gross proceeds from crypto and other digital asset sales.
Impact on Crypto Taxpayers
The temporary relief is a welcome development for crypto taxpayers who were concerned about the potential impact of the ruling on their tax obligations. However, the ultimate implications of this ruling remain to be seen, and investors are advised to maintain accurate records of their cryptocurrency holdings until Dec. 31, 2025.
Expert Insights
Crypto commentator Mark Thomas noted that FIFO can be beneficial in certain situations, such as when the sale date is more than one year after the earliest crypto purchased but less than one year after the latest crypto purchased. In this case, FIFO would mean long-term capital gains instead of short-term.
Timeline for Implementation
The temporary relief applies to sales on centralized crypto exchanges until Dec. 31, 2025. After that date, brokers will be required to support all accounting methods, and taxpayers will need to select their preferred method or face the default FIFO method.
Conclusion
The IRS’s decision to grant temporary relief for cryptocurrency holders on centralized exchanges is a positive development for investors who were concerned about the potential impact of the ruling. However, the ultimate implications of this ruling remain to be seen, and taxpayers are advised to maintain accurate records of their cryptocurrency holdings until Dec. 31, 2025.
Recommendations
Investors should:
- Maintain Accurate Records: Investors should keep accurate records of their cryptocurrency holdings, including purchase dates, prices, and quantities.
- Select Preferred Accounting Method: Taxpayers should select their preferred accounting method (HIFO or Spec ID) to avoid defaulting to the FIFO method.
- Consult with a Tax Professional: Investors should consult with a tax professional to ensure they are complying with all tax obligations and taking advantage of available deductions.
By following these recommendations, crypto taxpayers can minimize their tax liabilities and maintain accurate records of their cryptocurrency holdings until Dec. 31, 2025.